Growth Without Apology

Submitted by Shanta Devarajan On Mon, 06/30/2014

[1]From time to time, countries experience rapid economic growth without a significant decline in poverty. India’s GDP growth rate accelerated in the 1990s and 2000s, but poverty continued to fall at the same pace as before[2], about one percentage point a year. Despite 6-7 percent GDP growth, Tanzania and Zambia[3] saw only a mild decline in the poverty rate. In the first decade of the 21st century, Egypt’s[4] GDP grew at 5-7 percent a year, but the proportion of people living on $5 a day—and therefore vulnerable to falling into poverty—stagnated at 85 percent.

In light of this evidence, the World Bank has set as its goals[5] the elimination of extreme poverty and promotion of shared prosperity. While the focus on poverty and distribution as targets is appropriate, the public actions required to achieve these goals are not very different from those required to achieve rapid economic growth. This is not trickle-down economics. Nor does it negate the need for redistributive transfers. Rather, it is due to the fact that economic growth is typically constrained by policies and institutions that have been captured by the non-poor (sometimes called the rich), who have greater political power. Public actions that relax these constraints, therefore, will both accelerate growth and transfer rents from the rich to the poor.

Some examples illustrate the point.

Macroeconomic stabilization. Macroeconomic instability undermines growth and hurts poor people. A particular type of instability is when countries run significant current account deficits. In these cases, the real exchange rate is overvalued. But a devaluation is resisted because an overvalued exchange rate makes imports—something the rich consume—cheaper. Meanwhile, the poor, many of whom rely on tradable agriculture for their incomes, suffer. When the currency is finally devalued, as was the case with the CFA Franc in West and Central Africa in 1994, exports and overall growth accelerates, and poverty falls. To be sure, the higher domestic price of imports may hurt the urban poor, but this should be addressed with targeted safety nets, not by persisting with the overvalued exchange rate.

Trade reform. Based on the “infant-industry” argument, many countries protected their industries from import competition with tariffs. Unfortunately, the “infants” never grew up: they were captured by politically powerful people who demanded subsidies to remain in business, without any increase in productivity (the Morogoro shoe factory in Tanzania, for instance, never exported a single pair of shoes). Trade reform raised wages of relatively unskilled workers (who were abundant in poor countries) and lowered returns to capital (owned by the rich) in protected industries. It also stimulated growth because the economy was producing to its comparative advantage (low-skilled labor). The resulting employment creation and cheaper imports led to a decline in poverty. This was the experience of Latin America and East Asia. In Africa, the first wave of trade liberalization ran into difficulty because governments were not prepared for the loss in tariff revenues. Following the introduction of broad-based tax instruments, such as the value added tax, subsequent reforms have had a favorable effect on poverty and growth in Africa. In North African countries like Tunisia and Egypt, trade liberalization was accompanied by the capture of a number of non-tradable industries, such as banking, telecommunications and transport, by the firms[6] connected to the political leaders. The resulting high monopoly prices of non-tradable inputs to the exporting sector meant that exports, and therefore employment, never took off. In this case, the reforms needed to stimulate employment—increased competition in the non-tradable sectors—are the same as those needed to accelerate growth.

Agriculture. In low-income countries, most of the poor earn their living from agriculture. To reduce poverty, we need to increase agricultural productivity, which not only increases poor people’s incomes but also permits some of them to move to higher-productivity occupations in urban areas. The resulting structural transformation leads to higher growth and lower poverty—the pattern that all successful developing countries have followed.

Public action therefore should be aimed at increasing agricultural productivity and facilitating labor’s moving to higher-productivity occupations. Unfortunately, many policies are captured by the non-poor before they can have these effects. For instance, fertilizer subsidies typically go to the largest farmers with only marginal productivity effects. Even when the fertilizer is distributed through the market using a voucher system, a study[7] in Tanzania found that 60 percent of the vouchers went to families of elected officials.

Infrastructure. It is now well-established that infrastructure (bridges, roads, electricity grids, water networks) is important for economic growth. It is also a fact that poor people have the least access to infrastructure. So as a first cut, public action that increases poor people’s access to infrastructure will increase the quantity of infrastructure and generate growth.

But there is a more subtle way infrastructure, growth and poverty interact. Infrastructure services are extremely inefficiently delivered in most countries. Except for South Africa and Kenya, no country in Africa has a solvent electric utility. The reason is that electricity tariffs are considerably below costs. Not only does this underpricing lead to power cuts and dilapidated grids, but it contributes to excluding poor people from the grid. Politicians, who control the utility, make sure the cheap electricity goes to neighborhoods of their political clients. Poor people resort to candlepower, which costs about four times the meter rate. Ironically, increasing tariffs to costs may increase poor people’s access to electricity, because the utility is now accountable to the customer and not the politician. Needless to say, this is also the reason why politicians resist tariff increases.

Education and Health. Another well-established result is that human capital drives a country’s long-term economic growth. And it is the poor, rather than the rich, who lack human capital. The rich have both the incentives and the means to educate their children and keep them healthy. So an increase in the stock of human capital will mean that more poor people get educated and healthy.

The situation is more complicated when we realize that the rich have already captured public resources in both education and health. Governments spend about 200 times as much per student on higher education as they do on primary education. Yet about 60 percent of students at universities come from the richest quintile of the population. Public spending in health is overwhelmingly skewed towards hospitals, the lion’s share of which goes to the richest quintiles. As a consequence, governments under-spend on public goods such as immunization, which are likely to benefit the poor (the rich will immunize their kids without government assistance). Worse still, the quality of primary education and primary health care—which is what matters for poor people’s human capital—is appalling. Teachers in public primary schools in India, Tanzania, Kenya and Senegal are absent[8] about 25 percent of the time; doctors in primary clinics are absent about 40 percent of the time. The people earning these rents—the absentee teachers and doctors—come from the richest 10 percent in their countries. In sum, by rationalizing public spending in health and education towards public goods, and by restructuring incentives to deliver quality services, governments can both enhance growth and reduce poverty.

Almost a century ago, Charles Wilson said, “What is good for the country is good for General Motors—and vice versa.” The present-day equivalent is, “What is good for the poor is good for economic growth—and vice versa.”